RISK ON THE RUN, FED MUST DELIVER IN DECEMBER

With the news that certain polls have Trump ahead of Clinton we feel that markets remain compliance and underpriced to the real potential of a Trump victory

Wall Street continued its seven day correction lower, slipping below the psychological handle of 2100 for a short period

In the FX markets USD and JPY were both in high demand (alongside CHF) while MXN, CAD were under significant selling pressure

Fed: Likelihood of a rate hike stands at 75% in a scenario similar to last year

We believe that the Fed must deliver before year-end to repair its credibility and if it fails to do so, the stock market will experience a more abrupt sell-off

In our view, there will be no rate hike in 2017 but demand for dollar will increase

The one-two punch completely knocked the risk appetite out of financial markets. First came the news that certain polls had Republican presidential candidate Donald trump ahead in the national poll. We believe the markets remain compliance and underpriced to the real potential of a Trump victory. Before markets could recover from the shock, the Fed signalled that a December’s 25bp interest rate hike was likely. Wall Street continued its seven day correction lower, slipping below the psychological handle of 2100 for a short period. In the FX markets, our election currency basketwas in full reaction mode. USD and JPY were both in high demand (alongside CHF) while MXN, CAD were under significant selling pressure. FX markets remain highly correlated to the US elections and will remain volatile ahead of Nov 8th. Asian regional equity markets were able to fend off a complete capitulation sell off, yet a majority were lower. The Hang Sang fell -0.30% while the Shanghai composite rallied 0.84%. Asian stocks were supported by economic data indicating that that China’s service sector increased at its fastest pace in four months. Chinese Caixin PMI data firmed as the services gauge increased to 52.4 vs. 52.0 and the composite measured at 52.9 vs. 51.4. In commodities, gold continued to benefit from weak risk sentiment climbing to $1306. The crude slide continued as US oil inventories indicated a massive build-up. Crude Speculative interest has been caught long making unwinding positions difficult. News of an attack on a Nigerian oil pipeline has had a muted effect on oil futures.

As we had expected, the Fed held monetary policy unchanged yet shifted closer to a December rate hike as members indicated that the US economy “continued to strengthen.” Yet the Fed was waiting on “some” further evidence of firming near objectives before raising interest rates. Interestingly, the Fed statement removed reference to inflation expectation remaining low in the “near term” and reiterated the forecast that inflation will rise to 2% target over the mid-term. Fed fund futures pricing increased to 78% from 70% at the start of the week. The vote was 8-2 with George and Mester dissenting and Rosengren shifting back into the majority. Elsewhere, US private sectors (ADP) added a soft 147k jobs in October below the 202k in September. We continue to expect a cyclical deceleration in the US economic data which will keep the Fed from raising rates in 2017.

Yann Quelenn, market analyst: “Fed must strike in December: As widely expected by financial markets, the Fed has not moved its rate and monetary policy will remain unchanged until the December meeting. For now, the likelihood of a rate hike stands at 75%. Last year’s scenario is going to be played out again when the rate hike was also postponed until December.

Economic data is not the Fed’s main driving force.If they do deliver before year-end, then this action will be purely driven by a question of credibility. If it fails to do so, the stock market may experience a more abrupt sell-off. From a data standpoint, this week is far from over. The non-farm payrolls are due for release on Friday afternoon and this data will still be important to assess the true state of the US economy. One first element is that the ADP jobs report which were issued yesterday proved a disappointment with 145k jobs versus an 165k expected from economists. A change in NFPs is expected at 175k tomorrow.

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Also of interest at present is how stock markets are pricing in a higher likelihood of a Trump win. Hillary Clinton is definitely losing ground due to renewed controversy and the S&P is having its longest losing streak in five years. The index also closed below 2100 for the first time in four months. Though many question whether Trump would reduce the power of the Fed in the event of his election, we believe that the Fed would indeed keep its decision-making power. For the time being, the US central bank is far from running out of ammunition and while it sounds ironic, the Fed might very well increase rates slightly to save its credibility and launch a new QE to support growth. In our view, there won’t be any rate hike in 2017 but the demand for dollar is going to increase on the back of rising hopes that monetary policy will be normalized. Moreover, it is clear that the Fed is pushing for inflation and will allow the spread between real interest rates and nominal interest rates to widen in an effort to kill the country’s massive debt.” —-

Traders should expect a big day for GBP. In an uncertain event, the UK high court will issue a ruling on whether the government releases Article 50 without the consent of parliament. Should the government lose its case we would see a decent GBP bounce give the extensive short position. However, should they win, an appeal is clearly on the table for which the Supreme court has provided a hearing time on December 7th-8th. Regardless of the outcome, this legal appeal clearly provides additional uncertainty to what is already an extremely cloudy and complex situation.

In regards to the BoE this will be the most complete set of data since Brexit. We anticipate that the BoE will remain on hold as economic data remains firms despite the skeptics. Markets will be interested in the Quarterly Inflation Reports upward revision in inflation and growth which were both projected to evaporate after Brexit.

GBP has rallied in recent days in expectation of a strong UK and the probability of further policy actions had decreased, triggering a sharp sell-off in gilts. We continue to see short term GBP buying opportunities as the political driven Brexit story continues to capture headlines but lacks tangible results.

Elsewhere, markets will get US ISM non-manufacturing, factory orders, and durable goods orders.